FBAR penalties can be steep. Indeed, under current law, if a taxpayer “willfully” fails to file a timely and accurate FBAR, the taxpayer may be liable for civil penalties of $129,210 per year or 50% of the balance in the accounts at the time of the violation, whichever is higher.[i] And even non-willful violations—given the 6-year statute of limitations—can add up with civil penalties of $12,921 per year currently.[ii]
Because the amount of FBAR penalties often hinges on whether the conduct was “willful” or “non-willful,” tax practitioners must take careful notice of the distinction between the two when advising their clients of the results of failures to timely file. Thus, a recent federal court decision out of the Northern District of California is worth a read and provides some helpful insights to tax professionals and taxpayers alike as to how to potentially distinguish between the two types of conduct.[iii]
The Facts of Hughes
Ms. Hughes, a United States citizen, was born in Nevada in 1964. In 1986, she earned a Bachelor of Business Administration degree with a major in International Business and a minor in Political Science.
Sometime after college, Ms. Hughes established Hughes Bookkeeping Company, which provided bookkeeping and accounting services for its clients. As a bookkeeper, Ms. Hughes prepared accounts payable and check registers for businesses and also gathered documents to assist clients in the preparation of tax returns.
Eventually, Ms. Hughes utilized many of her skills as a bookkeeper to assist her mother, siblings, and approximately three to five friends prepare their returns.
New Zealand Foreign Investments
In 2001, Ms. Hughes formed Akaroa Convention Centre (2000) Limited in New Zealand. Although the entity went through several name changes, it was at all times owned solely by Ms. Hughes. Ms. Hughes also acted as the company’s sole director.
In 2013, Ms. Hughes formed Cuba Uncorked Limited in New Zealand. CU operated a wine bar in New Zealand. At all times, it was solely owned by Ms. Hughes.
As the sole owner of both New Zealand companies, Ms. Hughes had a financial interest in and signature authority over the company’s bank accounts at ANZ Bank New Zealand Limited from 2010 through 2013. In addition, the aggregate value of the financial accounts with ANZ Bank exceeded $10,000 each year.
Hughes’ Tax and FBAR Reporting
For the tax years 2010, 2011, 2012, and 2013, Ms. Hughes purchased TurboTax CDs to use to prepare her own tax returns.
For her 2010 and 2011 tax years, Ms. Hughes did not report any interest from foreign accounts on a Schedule B, Interest and Ordinary Dividends. However, Ms. Hughes did file Schedules B for her 2012 and 2013 tax years, which reported the following information to the IRS:
- On her 2012 Schedule B, Ms. Hughes reported interest income from “National Bank of New Zealand.” She also answered “Yes” to the first question on Line 7a of Part III, Foreign Accounts and Trusts (“At any time during 2012, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country?”). Hughes also answered “Yes” to the second question on Line 7a (“If ‘Yes,’ are you required to file Form TD F 90-22.1 to report that financial interest or signature authority? See Form TD F 90-22.1 and its instructions for filing requirements and exceptions to those requirements.”). On Line 7b, Ms. Hughes wrote “NZ New Zealand,” or the line which requests taxpayers to enter the name of the foreign country where the financial account is located.
- On her 2013 Schedule B, Ms. Hughes answered “Yes” to the first question on Line 7a indicating that she had a foreign account. However, she answered “No” to the second question on that line that indicated that she was not required to file an FBAR for the 2013 reporting year.
From 2010 through 2013, Ms. Hughes did not file FBARs with the IRS until the IRS initiated an examination of these tax years.
In 2013, an IRS auditor contacted Ms. Hughes. Originally, the IRS agent focused the scope of the examination on her 2011 income tax year. However, the IRS agent later expanded the scope of the audit to include Ms. Hughes’ 2007 through 2013 tax years, including failures to file Forms 5471, Forms 926, and FBARs.
On August 21, 2014, the IRS issued Ms. Hughes an informal document request (“IDR”) associated with her FBAR filings for the 2011, 2012, and 2013 tax years. In response to the IDR, Ms. Hughes filed late and delinquent FBARs on September 11, 2014.
On January 1, 2015, the IRS issued Ms. Hughes another IDR. In that request, the IRS sought a copy of Ms. Hughes’ FBAR for the 2010 tax year. In response to the IDR, Ms. Hughes filed a late and delinquent FBAR.
After the IRS agent concluded the examination, the agent proposed willful and non-willful FBAR penalties against Ms. Hughes for her 2010 through 2013 tax years. In addition, the IRS agent proposed over $600,000 of additional income taxes for the years 2010 through 2014 and additional penalties for her failure to timely file Forms 5471 and Forms 926 for various years.
The Hughes Decision
When Ms. Hughes failed to pay the assessed willful FBAR penalties, the government filed a complaint against Ms. Hughes in the Northern District of California seeking to reduce the assessments to judgment. Ms. Hughes filed an answer and denied that she was liable for the willful FBAR penalties.
The parties engaged in a two-day trial. Before discussing the parties’ respective proof at trial, it is important to quickly go over the government’s burden of proof on the essential elements of a willful FBAR penalty claim. In this case, to prove that Ms. Hughes engaged in willful conduct, the government was required to show facts that showed that: (1) she was a U.S. person; (2) she had an interest in or authority over the foreign accounts; (3) the accounts had an aggregate value of $10,000 or more at any time during the year; and (4) she willfully failed to file an FBAR.[iv] Moreover, to meet its burden of proof, the government had to further show each of these elements by a preponderance of the evidence. [v]
Because Ms. Hughes conceded that the government could prove elements (1) through (3) above, only element (4) or the willfulness element remained in dispute. And, at trial, the government was well aware that it was not required to show intentional conduct to meet its burden of proof for willful conduct—indeed, the government recognized that federal courts across the United States had held that the government may meet its burden of proof through showing reckless conduct or willful blindness.[vi]
At trial, the government relied on two witnesses: (1) a tax content analyst for Intuit, which makes TurboTax; and (2) the IRS agent responsible for the examination of Ms. Hughes 2010 through 2013 tax years. With respect to the Intuit employee, the government elicited testimony regarding how the Schedules B were prepared internally by TurboTax for each year of 2010 through 2013, based on user prompts and responses. And, the government utilized the IRS agent to testify as to various conversations he had with Ms. Hughes during the course of the examination.
Based on the evidence at trial, including the above testimony, the federal court concluded that Ms. Hughes was not willful with respect to her 2010 and 2011 tax years but was willful with respect to the remaining 2012 and 2013 tax years. More specifically, the court reasoned that, with respect to the 2010 and 2011 tax years: (1) there was no evidence that Ms. Hughes reviewed Schedules B at any time before she filed 2010 and 2011 tax returns; (2) there was no evidence that Ms. Hughes was aware of the FBAR filing requirement when she filed her 2010 and 2011 tax returns; (3) there was no evidence that TurboTax ever prompted Ms. Hughes to complete and file an FBAR. However, with respect to the 2012 and 2013 tax years, the court concluded that: (1) in preparing her 2012 tax return, Ms. Hughes reviewed and completed Schedule B, including its questions regarding foreign bank accounts and the FBAR filing requirements; (2) in light of her checking the box that she was required to file an FBAR for that year, her testimony that she thought that she was not required to file an FBAR that year because her interest income had been subject to New Zealand taxes was not credible; (3) in preparing her 2013 tax return, Ms. Hughes reviewed and completed Schedule B, including its questions regarding foreign bank accounts and the FBAR filing requirement; and (4) in light of her checking the box, she saw the admonitions on Schedule B to read the instructions regarding FBAR requirements and failed to do so.[vii]
In summing up its conclusions above, the court also had this to say regarding the distinction between the 2012/2013 tax years and the 2010/2011 tax years:
This Court need not resolve the significance of Hughes’ signatures on her returns. With respect to her 2012 and 2013 returns, there is no doubt that Hughes saw the questions about filing an FBAR, because she answered them (and in 2012, stated that she was required to file one). In 2010 and 2011, Hughes’ returns did not include Schedule B, so the certification that she ‘examined this return and accompanying schedules and statements’ does not encompass that schedule and its admonitions about the FBAR. The United States has identified nothing in Hughes’ 2010 or 2011 returns as actually filed that, if ‘examined’ as she certified, would have put her on notice of the FBAR requirement.
The circumstances of Hughes’ 2010 and 2011 tax returns differ from 2012 and 2013. Unlike those later years, there is no indication that Hughes reviewed Schedule B, with its instructions regarding the FBAR requirement, in preparing her 2010 and 2011 returns or any time before she did so. In the absence of any evidence that Hughes was aware of the FBAR filing requirement when she completed her returns for those years, or that she was presented with any information that should have put her on notice of that requirement, the United States has not met its burden to show that her failure to file FBARs in those years was anything more than negligent. The United States therefore cannot assess penalties for ‘willful’ violations for those years.
Similar to prior federal court cases on these issues, the Hughes decision provides some additional clarity on the distinction between willful and non-willful conduct. But, perhaps more importantly, it provides a roadmap of the evidence that the government will look at in building a case against a taxpayer for willful conduct. For example, because the government failed to provide evidence that Ms. Hughes was aware of her FBAR filing requirement when she completed her returns for 2010 and 2011 or that information was presented to her that should have put her on notice of that requirement, taxpayers and tax professionals can expect the government to try to dig deeper into obtaining evidence on taxpayers to satisfy their burden of proof on reckless and willful blindness behavior. Moreover, taxpayers and tax professionals involved in various IRS amnesty programs—such as the voluntary disclosure program or the IRS streamlined submission procedures—should look to the analysis in Hughes, among other relevant federal court cases, in determining the appropriate program for their clients.
FBAR penalty defense requires a proactive representation and a deep knowledge of the nuances of FBAR compliance and its defenses. Freeman Law represents clients with offshore tax compliance disputes involving FBAR penalties and international information return penalties. Failing to file an FBAR can give rise to significant penalties, including a non-willful penalty and willful FBAR penalty. The risks of tax and reporting non-compliance have never been more real and the threat of international penalties, particularly FBAR penalties, has never been more clear. Schedule a consultation or call (214) 984-3000 to discuss your FBAR penalty concerns or questions.
[i] See 31 U.S.C. § 5321.
[ii] See id. In various instances, the government has taken a litigating position that non-willful FBAR penalties may be assessed per year, per account rather than simply by year.
[iii] United States v. Hughes, Case No. 18-cv-05931-JCS, 128 AFTR 2d ¶ 2021-5309 (N.D. Cal. 10/13/21).
[iv] See U.S. v. Pomerantz, No. C16-689 MJP, 2017 WL 4418572 (W.D. Wash. Oct. 5, 2017).
[v] See U.S. v. Garrity, 304 F. Supp. 3d 267, 270 (D. Conn. 2018) (“[E]very court that has answered the question . . . has held that the preponderance of the evidence standard governs suits by the government to recover civil FBAR penalties.”).
[vi] U.S .v. Horowitz, 978 F.3d 80, 88 (4th Cir. 2020); Bedrosian v. U.S. Dept’t of the Treasury, 912 F.3d 144, 153 (3d Cir. 2018); U.S. v. Williams, 489 F. App’x 655, 658 (4th Cir. 2012); U.S. v. Flume, 390 F. Supp. 3d 847, 854 (S.D. Tex. 2019); see also Safeco Ins. Co. of Am. v. Burr, 55 U.S. 47 (2007) (“where willfulness is a statutory condition of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.”).
[vii] In many cases, a taxpayer may contend that he or she did not read the instructions on Schedule B regarding the FBAR requirement. As the Hughes court correctly recognized, some courts have held that the signing of a tax return alone puts the taxpayer on constructive notice of the Schedule B instructions and FBAR requirements. See, e.g., Williams, 489 F. App’x at 659; U.S. v. McBride, 908 F. Supp. 2d 1186, 1206 (D. Utah 2012). Other courts have rejected this view as undermining the statutory distinction between willful and non-willful violations. See Flume I, 2018 WL 4378161, at *7, U.S. v. Schwarzbaum, No. 18-cv-81147, 2020 WL 1316232, at *8 (S.D. Fla. Mar. 20, 2020).